VALUATION OF SHARES

Need for the valuation of shares.

 When two or more companies amalgamate

or one company absorb another company
 When a company has decided to undergo a
process of reconstruction
 When preference shares or debentures are
converted into equity shares
 Shares are often pledged as security for
raising loans
 When one company acquires majority of the
shares of another company it is necessary to
value such shares.
 The survivors of deceased person who get
some shares of company made by will,
 Under a scheme of nationalization when the
shares of a company are taken over by the
government.
Method of Valuation of shares

 Method of valuation of shares depends on

the purpose and factors affecting the
valuation of shares
 There are certain judicial decisions with
regard to valuation of shares.
 The Bombay High Court (ITR 799) concluded
that in a company which is running concern,
the market value of shares is determined
mainly on the basis of the yields methods
because a person who holds the shares or
who want to purchase shares does it in the
hope of getting the adequate return on his
investments.
 The Supreme courts (ITR 38) held that where
the shares of Public limited company are not
quoted on any stock exchange or shares of
the private company, the proper method of
valuation of shares would be the profit
earning method.
The court has laid down following
principles for share valuation
 Where the shares in the public limited
company are quoted on the Stock Exchange,
the price prevailing on the valuation date is the
value of shares.
 Where shares are of private company or of a
public company which are not quoted, the
value is determined by reference to the
dividend reflecting the profit earning capacity
on a reasonable commercial basis. Otherwise
the amount of yields would determine the
value of the shares.
 Where the total Yield and earning method
breakdown by reasons of the company’s
inability to earn profit and declare dividends.
In that case value would be discounted by
the percentage corresponding to
proportionate fall in the quoted prices
 Where expense are incurred out of
proportion to the commercial venture these
would be added back to the profit while
computing yields. In case of private
companies the restriction on the transfer of
shares would be taken into account in
arriving at the value of shares.
Various Methods
of valuation of shares
I. Net Assets value (NAV) Method

 This method is called also called Intrinsic

Value Method or Break up value method or
Asset Backing method.
 Under this method the net assets (assets-
liabilities) are calculated and divided by the
number of the shares to get the “net assets
value “per share.
 To determine the “intrinsic Value” (Net
Assets Value) of equity shares the claims of
preference shareholders must be deducted.
 The claims of preference shareholders
include the paid up value of preference
shares and arrears of dividends thereon (for
cumulative preference shares).
 If Preference shares have a right to
participate in the surplus (as it happen in
case of liquidation) the amount should also
be deducted and included in the preference
shareholders claims
Equity shares with different paid up
values

 The company has issued shares with

different face values
 The company has issued shares with only
one face value but with different paid up
value.
The company has issued shares with
different face values

 The value of equity shares shall be

calculated on the basis of “unit value” of
capital.
 The unit value will be multiplied by the paid
up value of different lots to get the intrinsic
value per share.
The company has issued shares with only
one face value but with different paid up
value.
 The value of equity shares shall be determined
after the notional call
 The total net assets will be divided by the total
number of equity share
 This will give the value of each fully paid equity
share
 Unpaid amount of each share will be deducted
from each value to ascertain the value of partly
paid up shares
Valuation of Preference shares

 A preference shareholder is particularly

interested in the security of capital and
consistency of returns.
 That is why he is anxious for a priority of
repayment of his capital/dividend or both.
 The following points must be kept in the mind
while calculating the value of preference
shares.
 If preference shares are non-cumulative and
non-participating the value of each
preference shares shall be equal to its paid
up value
 If preference shares are cumulative and non-
participating the value will be determined
after arrears of preference dividend are
added back to their paid up capital
 In the case preference shares are cumulative
and participating then besides arrears they
will also be entitled to shares in the surplus of
the company, left after returning equity
capital.
 However, if the preference shares do not
have any preference (priority) with regard to
repayment of capital and dividend, the values
of preference shares shall be calculated as if
these are equity shares
II. Yield Method

 This method takes into account the future

prospects in terms of return on investment.
 This method is based on the assumption that
the company is going concern. It will continue
its activity year after year. Therefore, value of
shares is based on the Dividend yield or
Earning yield
Dividend yield

 When the shareholder has little or no

influence over dividend policy valuation of
shares may be based on dividends.
Following points should be consider while
deciding profit available for equity dividends.
 Average profits
 Provision for depreciation, taxation and other
liabilities payable.
 Provision for preference dividend.
 Transfer to General reserve
Procedure
Find out the F.M.P.
Particular Amount Amount

Average profit xx

Add: Expenses & losses incurred so far, but not likely to be incurred in future xx

Add: Income & Gain not earned so far, but likely to be earned in the future xx

xxx

Less: Expenses & losses not incurred so far, but likely to be incurred in future xx

Less: : Income & Gain not earned so far, but likely to be earned in the future xx xx

xxx
 F.M.P.
=F.M.P. after taxation-Preference dividend-
Transfer to reserve as under law contracts
Decide the rate of F.M.P./Expected rate
of dividend

 Rate of F.M.P.
= F.M.P X 100
paid up equity capital
Work out yield value

Rate of F.M.P. X Amount paid per share

Normal rate of return
Value of share can be calculated as

Rate of dividend X Paid value of share

Normal rate of return
or

Dividend per share X 100

Normal rate of dividend
Earning yield

 Under this method share are valued on the

basis of earning expected. Earning are
expected are calculated on the basis of
average recent years profits following steps
should be taken:
 Find out the profit after tax
 Calculate expected rate of ratings

= Profit after tax X 100

Paid up value of shares
 Work out the value of shares
= Expected rate of earning X face value of shares
N.R.R.
III. Earning Capacity Method

 This method takes into account the earning

potentials of a company rather then return of
the shareholders.
 The earning capacity method takes into
account total earning of the company before
any appropriation.
This method involves the following
steps.

 Calculation of future maintainable profits.

 Calculation of capital employed.
 Ascertaining the rate of earnings.
 Determining the normal rate of return.
 Determination of value of shares.
Calculation of capital employed

 The capital employed should mean Equity

capital employed as i.e. Equity capital plus
retained earning. The preference share
capital, The Long term borrowing and
debentures were to be excluded.
Ascertaining the rate of earnings
Rate of earning
= Profits after interest, tax & preference
dividend X100
Equity capital
Determination of value of shares

 Value of Equity shares

= Earning Rate X Paid up value
Normal rate of return
IV. Capitalization of Earning Capacity
Method

 Under this method profits available for equity

shareholders as calculated under
capitalization of method, are capitalized on
the basis of normal rate of return.
 Then the value of equity shares is
ascertained by dividing the capitalized profits
by the number of equity shares as shown
under
Capitalised Value of profits
= Future Maintainable Profits X100
Normal Rate of Return
Value of Equity shares
= Capitalised value of Profits
No. of equity shares
V. Fair value method

 Fair value is simple an average of Intrinsic

value and yield value or Earning capacity
method.
Fair value of shares
= Intrinsic values + Yield value
2
Or
= Intrinsic value + Capitalised/Earning capacity
2